Watch Out For Falling Gasoline Prices

The failure of oil-producing nations to agree this week on boosting output sparked worries that the price of crude and gasoline could be headed higher again.

But a number of oil industry watchers think those worries are misplaced.

“Right now the real story is not so much what's happening in Vienna,” where OPEC leaders met, said Nansen Saleri, CEO of oil reserve adviser Quantum Reservoir Impact. “The real story is what's happening in Libya and what’s happening in the global economy, particularly in the U.S.”

For U.S. drivers, the real story is that pump prices are falling for several reasons.

First, demand has fallen. At $4 a gallon, drivers have figured out how to cut back — either by driving less or switching to more fuel-efficient cars and trucks. Despite fears of possible tight supplies of crude, there are ample inventories of gasoline to last through the summer driving season. Prices are already retreating from the $4 mark.

Falling oil prices get much of the credit. Crude prices had already begun falling well before this week’s public display of disaffection among the world’s biggest producers.

Since peaking at around $127 a barrel in April, oil prices have backed down by about $15 even after this week's modest increase.

Much of the spring price surge followed the outbreak of revolution across the Arab world including the loss of production from embattled OPEC member Libya. But despite the loss of production, oil is still plentiful. In the U.S., oil stocks are well above their five-year average for this time of year.

The Libyan civil war also raised fears that unrest could spread to Saudi Arabia, disrupting output by the last producer with meaningful spare capacity. But as those fears have eased, so have oil prices.

“One can argue there are still risks everywhere else in the Middle East, including Saudi Arabia,” said Saleri. “But they have a set of circumstances that make them far, far more stable and very different than the rest of the countries in the oil-producing region.”

The Arab spring has clearly rattled OPEC. This week’s meeting highlighted a major rift in the cartel, with Iran arguing against raising output and Saudi Arabia arguing for it. Though OPEC has long been plagued by internal squabbles, they are typically papered over with a formal statement of unity. So the public display of acrimony was unusual.

"This is one of the worst meetings we have ever had," Saudi oil minister Ali al-Naimi said after the meeting broke up not long after it started.

On Friday, Saudi newspaper al-Hayat reported that Saudi Arabia planned to raise output to 10 million barrels a day in July, from 8.8 million bpd in May. There was no indepedent verification of the story.

Oil prices may have shown little impact even if traders had gotten the production increase they expected. With many OPEC members already cheating on production quotas, OPEC’s actual output is running about 1 million to 2 million barrels per day above the official target. Production hawks like Iran and Venezuela — who opposed calls from the Saudis for higher production — face ruinous revenue shortfalls if they hold back oil supplies.

“Even those members who voted against (raising production) may be tempted to take advantage of higher prices and allow their compliance to slip further,” said Julian Jessop, who follows the oil markets for Capital Economics.

In any case, efforts to raise production fall squarely on the Saudis, the only country with significant spare capacity to add to global supplies. And contrary to popular belief, the Saudis are just as worried when oil prices rise too high as when they fall too far.

“They're all about stability and the long-term marketplace because, after all, the Saudis only export one thing,” said Addison Armstrong at Tradition Energy. “They have only one source of revenue, so they don't want anything to mess around with it. They want to be on this gravy train as long as possible and stability of price is the key to that.”

So as the world’s largest producer, Saudi Arabia has the most to lose from the recent surge in oil prices, which has only served to accelerate global efforts to use less Saudi oil.

Higher oil prices have sparked a major shift in car buying habits, for example. U.S. car dealers last month reported continued strong demand for smaller, fuel efficient vehicles. General Motors is considering adding a second shift to the Detroit plant that makes the electric Chevy Volt. Ford said Friday it plans to triple production of electric cars by 2013.

Oil prices above $100 have spurred production of alternative sources of oil that cost more to produce, from Canadian tar sands to ever-deeper offshore oil fields. Exxon Mobil said this week it made two big new deepwater oil discoveries in the Gulf of Mexico in an area thought to hold as much 15 billion barrels of crude.

Domestic oil finds that were once considered too costly to produce are now being developed profitably with production techniques like steam injection and fracking, which cracks open rock formations deep underground to get at the crude.

Those techniques have also produced something of a modern-day boom in U.S. natural gas production, pushing prices lower and making it much more attractive as an alternative transportation fuel.

Gulf Oil, a major gasoline retailer, is among the companies looking to expand the use of natural gas for transportation, according to CEO Joe Petrowski.

“So from a demand standpoint, there's a lot of destruction going on of petroleum demand for the first time I’ve seen in a long while,” he said. “People are not just talking about it but putting pencil to paper and looking to use less petroleum-based fuels.”

In the U.S., gasoline demand has fallen by roughly 5 percent since this time last year; prices recently backed off after peaking at about $4 for a gallon of regular.

Petrowski is among those who think pump prices are headed lower: He sees prices at $3.50 or below by July 4.

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